Before we get to the good stuff, let’s review some history of economic thought.
In 1920, the Austrian economist Ludwig von Mises argued that socialist economies would not be able to figure out what to produce, how much of each thing to produce, and the best choice of inputs for the production. The price system does all that, and central planners could not duplicate the workings of the price system.
Oskar Lange, a Polish economist, replied with an answer that would be natural to any graduate student in economics: price reflect ratios of preferences and productivities. With all the relevant information and with sufficient computing power, equations could be solved that determine what should be produced.
Fredrich Hayek, another Austrian and eventually a Nobel laureate, then jumped in and pointed out that much of the information needed is down at the level of the worker. The factory maintenance mechanic knows that this machine needs lots of grease, but that machine needs only a little. Such job-specific information is too vast to flow up to the central planners. Hayek also said that in an ever-changing world, the central planners would be working on old consumer preferences and technological possibilities; they could never be up to date.
I roll this into a concept called “The Trial and Error Economy,” which emphasizes that neither central planning nor corporate planning can figure out all the production decisions. Instead, we make progress by trying one thing after another. Then we do more of what worked, and less of what didn’t work.
Consider the dying of pubic hair. Who would have thought that the world’s scarce resources needed to be devoted to this consumer need? Who knew it was a consumer need? But apparently there is a demand, and someone stepped up to fill it. The March 2007 issue of Business 2.0 has an article (not yet online) about Betty Beauty, a company that sells dye especially designed for “the hair down there.”
On the company’s web site, founder Nancy Jarecki tells her story of discovering women at a beauty salon taking some dye home in a “doggy bag.” She realized that there was demand by women who wanted the carpet to match the drapes. She developed a dye suitable for close proximity to “this sensitive area.”
Ladies and gentlemen, this is how capitalism works. No planner, neither in a government bureaucracy nor a corporate hierarchy, could possibly know about every conceivable product or service that consumers might find worthwhile. We count on some greedy entrepreneur to take a gamble, give it a try, and learn whether there is, indeed, a market for the new product. That’s the trial and error economy.